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Thread: The 'Pernicious Nonsense' Of Maximizing Shareholder Value

  1. #1

    The 'Pernicious Nonsense' Of Maximizing Shareholder Value

    https://www.forbes.com/sites/stevede...reholder-value

    Maximizing diversity is more important than the shareholder value.

    APR 27, 2017 by Steve Denning
    Opinions expressed by Forbes Contributors are their own.

    The Economist recently declared maximizing shareholder value to be “the biggest idea in business.” It may well be the biggest idea, but it’s also “the error at the heart of corporate leadership,” according to the current issue of Harvard Business Review in an article by two distinguished Harvard Business School professors — Joseph L. Bower and Lynn S. Paine. Maximizing shareholder value, they write, is “flawed in its assumptions, confused as a matter of law, and damaging in practice.”

    Bower has long held this view. When shareholder value was first put forward by Milton Friedman in 1970, Bower, then a young associate professor at Harvard Business School, was interviewed by National Public Radio. He told NPR that maximizing shareholder value as the sole goal of business was “pernicious nonsense.”

    But the pernicious nonsense has spread. Shareholder value thinking, the article says, “is now pervasive in the financial community and much of the business world. It has led to a set of behaviors by many actors on a wide range of topics, “from performance measurement and executive compensation to shareholder rights, the role of directors, and corporate responsibility.”

    In fact, shareholder value is now no longer just an idea, but, according to the article, an entire “thought system.” It has been embraced, the article says, by hedge fund activists, institutional investors, boards, managers, lawyers, academics, and even some regulators and lawmakers. It is “weakening companies” and “damaging to the broader economy,” with negative effects on “corporate strategy and resource allocation.”

    It has “increased the power and influence of certain types of shareholders over other types… and other important constituencies — without establishing any corresponding responsibility or accountability on the part of shareholders who exercise that power. As a result, managers are under increasing pressure to deliver ever faster and more predictable returns and to curtail riskier investments aimed at meeting future needs.”

    The HBR article points out that shareholder value thinking is quite recent in origin. It stems from the work of three academic economists in the 1970s — Milton Friedman, William Meckling and Michael Jensen.

    I talked with Bower and Paine this week and asked: How did these academics come to have such an immense influence?

    The Meckling/Jensen article in 1976, says Bower, was taken seriously by academics, as mathematical economics began to be applied to all kinds of social problems. At the time, there was a growing but illusory belief that economics could be as robust as the physical sciences. The article, replete with esoteric mathematics, wasn’t much read in the business community

    "It’s also important to remember," Paine told me, "that when these ideas were put forth, there were serious problems with corporate governance in many companies — figurehead boards, self-serving CEOs, and managers oblivious to the changing competitive environment. In many cases, shareholders were not being well served. So, the flaws in theory were overlooked in part because it was felt to be responsive to a real problem."

    Bower points to the 1990 article in HBR by Michael Jensen and Kevin Murphy, which really got shareholder value thinking going in business. The article, “CEO Incentives—It’s Not How Much You Pay, But How” suggested that CEOs were being paid like bureaucrats and that this caused them to act like bureaucrats. "Is it any wonder," Jensen and Murphy wrote, "that so many CEOs act like bureaucrats rather than the value-maximizing entrepreneurs companies need to enhance their standing in world markets?" Instead, they should be paid with significant amounts of stock so that their interests would be aligned with stockholders.

    “That article,” Bower told me, “was very well received in Wall Street. They loved it. You could see the change in compensation practices. The use of the phrase ‘maximize shareholder value’ exploded at that time.”

    And indeed, CEOs became very entrepreneurial — but in their own cause, not necessarily the organizations’ cause. The impact on CEO compensation practices has been mind-boggling. Even as real organizational performance in terms of the rates of return on assets has been drastically declining, studies by Lazonick and Hopkins show that in the period 1978 to 2013, CEO compensation increased by an astonishing 937%, while the typical worker’s compensation grew by a meager 10%.

    I asked Bower what was to be done when a whole economy is being run on a dynamic that is counter-productive. Does this go on until there is a massive financial crash that finally wakes society out of its complacency and forces a recognition that something is terribly wrong?

    “Shareholder value thinking has already done a lot of damage,” Bower told me. “and it will continue to do so. There are so many pieces to it. It’s not as if we need new regulations. The courts have been very good at defending any board that stands up to an activist shareholder attack and says that this is not in the best interest of the company. The business judgment rule is very powerful. We’re going to have to think about board reform in terms of what they can do and should do. I have served on boards that have told raiders to go away and they do. It’s true that the attacks have become more aggressive in recent years. We now have whole wolf-packs of investors. But it still remains true that you can fight them off. In some cases, as with the attack on Dupont by Trian, Dupont’s board' was described by a colleague at Yale as 'wimping out'.”

    How to create the necessary backbone to do what’s right? Bower said he was gratified by the reaction to the current HBR article. The article, he says, “has gone viral. There’s been a very positive response.”

    Would that be enough to elicit change when we are dealing, not just with an idea, but with a whole “thought system” embedded in society at large?

    “That’s a good question,” said Bower. “We held a workshop two years ago with banks and asset managers There was no dispute that there was a problem. They were particularly concerned about the role of boards. They thought that managers were more willing to stand up than their boards were. The general thrust of the discussion was that boards wanted to avoid public controversy. The asset managers acknowledged that their own practices were part of the problem: they were evaluating their own managers on the basis of quarterly performance. To solve this issue, you have to address the whole question of how shares are owned and what that means.”

    "For the system to change," Paine told me, "we’ll also need leadership in the shareholder community. We’ll need to see more shareholders and asset managers taking a genuine interest in the health of the companies they invest in – and not just in the companies’ share price. This is complicated given the nature of shareholding today and especially given the increasing popularity of index funds."

    "Creating value for shareholders," Paine told me, "is a crucial aspect of companies’ performance — but it’s not the only one and it’s not a license to run roughshod over everyone else. Paradoxically, when it’s taken in this way, it’s not even good for shareholders, at least not for shareholders in it for the long haul."

    The prominence that Harvard Business Review has given to the problem of short-termism and shareholder thinking in its current issue is encouraging. The issue, including the Bower/Paine article, provides powerful rational arguments as to why shareholder value thinking is financially, economically, legally, socially and morally wrong. Yet there are powerful vested interests in keeping things as they are. As Upton Sinclair pointed out a century ago, “It’s hard to get a man to understand something when he is being paid not to understand it.”

    In his book, Fixing the Game, Roger Martin makes the case that if the NFL had become corrupted by gambling and manipulation of the score, everyone would be calling on the NFL Commissioner to intervene and ban the coaches and players involved so that teams could get back to playing the real game of football. Yet in business, when it is now obvious that shareholder value thinking has corrupted management and has led to the massive extraction of assets and illegal stock price manipulation on a macro-economic scale, society has remained silent too long.

    As Bower and Paine pointed out their 2011 book, Capitalism at Risk, the stakes are high. Amid widespread distrust of business, “you cannot achieve a sense of legitimacy if large numbers of people think that the system doesn't work for them or is unjust to them." As the business ecosystem heads off the rails, business needs to act out of enlightened self-interest.

    Business leaders must move beyond being simply practitioners of capitalism and become its stewards, working to enhance the sustainability of the market system. Setting aside what Jack Welch has called “the dumbest idea in the world” is a big part of that stewardship.
    Last edited by timosman; 05-21-2017 at 05:52 AM.



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  3. #2
    "Creating value for shareholders," Paine told me, "is a crucial aspect of companies’ performance — but it’s not the only one and it’s not a license to run roughshod over everyone else. Paradoxically, when it’s taken in this way, it’s not even good for shareholders, at least not for shareholders in it for the long haul."

    So she completely ignores what Friedman said, created her own interpretation of shareholder value and then straw manned the argument. And then points out something that disproves her whole point.

    Reading the interpretations of what Friedman said is like reading all the false interpretations of libertarianism in general that people project. Maximizing shareholder value is the same thing as maximizing rational self interest in Ayn Rand's view. You don't accomplish that by cheating, stealing, cutting corners, treating employees poorly, and managing affairs just for the short term. Acting with integrity with a long term focus is part of maximizing shareholder value and part of acting selfishly.

  4. #3
    Article talks a lot, mostly via innuendo, yet says very little of direct intelligibility. As is typical of this ilk of personality, valid observations are made, however sparingly, and then all the wrong conclusions are reached.

    A hall mark of these sorts of articles is the false dichotomy. In this case the implication is that we are either responsible or we are capitalist, ignoring the fact that not only can we be both, but that most companies are. The innuendo of false assumptions is lousy in this article. There are in any event a small handful of near-reasonable statements. To wit:

    Quote Originally Posted by timosman View Post
    "Creating value for shareholders," Paine told me, "is a crucial aspect of companies’ performance — but it’s not the only one and it’s not a license to run roughshod over everyone else. Paradoxically, when it’s taken in this way, it’s not even good for shareholders, at least not for shareholders in it for the long haul."
    Correct insofar as it goes, but the author leaves out universes of information that could have been nutshelled in reasonable space by an honest and capable writer.
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  5. #4
    The talking heads on TV will often talk about shareholder value. For example, they keep saying that tax cuts will result in higher wages. So apparently, increasing wages for employees (i.e. increasing costs), in the absence of a need to increase wages, is somehow good for shareholders?
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  6. #5
    Quote Originally Posted by Brian4Liberty View Post
    The talking heads on TV will often talk about shareholder value. For example, they keep saying that tax cuts will result in higher wages. So apparently, increasing wages for employees (i.e. increasing costs), in the absence of a need to increase wages, is somehow good for shareholders?
    Well, you see, in America the government often shortcuts the free market feedback mechanism and engages in social engineering directly. Would you like to hear how successful they are with their diversity efforts? How about helping the less fortunate? We have plenty of those stories for every occasion.

  7. #6
    To be fair, Friedman's original theory has generally fallen out of favour since the 2001 and 2008 crashes, where companies that had seemed to model this idea failed, and many pursued short-term shareholder value in a destructive way. Friedman assumed a kind of self-correcting, idealized market that really hasn't existed. He ignored a lot of the real human factors(self-serving managers, a compliant board of directors, ineffective government regulators, uninformed shareholders, optimistic bond holders).

    Still, shareholder value theory is the best idea out there, just not in the clean-cut way Friedman presented it out to be. I do think that we are seeing markets evolve in a very slow way to the issues outlined above.

  8. #7
    If the usa was a company, what is the purpose of the government because they definitely not maximizing value for most people.

  9. #8
    Quote Originally Posted by gaazn View Post
    If the usa was a company, what is the purpose of the government because they definitely not maximizing value for most people.
    Printing coupons for the company stores.



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